"Emanuel Derman on Twitter, on volatility products"
Matt Levine
at Bloomberg View, May 19:
Elsewhere here is Emanuel Derman on Twitter, on volatility products:
This
isn't deep, but I think part of the reason vol is low is because vol
has become an asset class. Once upon a time you had to buy or sell
options and hedge them to trade vol, because an option gave you exposure
to both stock price AND volatility.
Think about CDS. Once upon a
time you had to buy corporates & short T-bonds to trade credit,
because a corporate had risk of credit and rates. Then with the
invention of CDS that gave pure exposure to credit, it became easy to
speculate on credit. And eventually a credit bubble.
Similarly
the invention of variance swaps and the VIX led to a way to trade
volatility as an asset class, and to think of it that way. And hence
easy to speculate on volatility, to sell it without having to hedge
equity exposure, and hence (perhaps) a volatility bubble.
If
you believe in efficient markets, then moving from one form to another
-- from bonds plus Treasury hedging to credit-default swaps, or from
options plus stock hedging to VIX products -- should be just an
administrative convenience; it shouldn't change anything in the real
world. But of course the point of a bubble is that it is a breakdown in
market efficiency, an irrational event. And "irrationality occurs when a
previously difficult thing becomes easy" is a pretty satisfying
explanation: If it's hard, you have to be smart to do it; if anyone can
do it, then irrational people will....